Charles Brandes’ picks for value investors

By Dean DiSpalatro | September 12, 2013 | Last updated on September 12, 2013
4 min read

U.S. tech. Europe. Japan. Emerging markets.

That’s where bottom-up investors should look for undervalued stocks, say Charles Brandes, chair of Brandes Investment Partners, and Louis Lau, the firm’s director of investments.

The recovery in the U.S. is “bumpy and slow,” says Lau, “but key indicators like housing and unemployment are moving in the right direction.” Utilities and industrials have become expensive; so have companies focused on dividend yield.

But he sees opportunities “in some of the boring names in the tech sector, like Microsoft and Western Digital.”

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The market is mistakenly focusing on the 20% of Microsoft that may run into some difficulty. Lau cites the firm’s cash investments and specifically its acquisition of Nokia’s smartphone business. “Eighty percent of its value comes from enterprise servers and Windows, and that’s being ignored. Windows and Office have a high piracy rate; when it’s reduced earnings will likely grow.”

When he bought Microsoft it was between 8x and 9x earnings. “And there’s still some value left.”

Read: Microsoft revamps Windows 8 due to weak sales

If you’re reading this on a desktop, there’s a good chance it’s equipped with a Western Digital hard drive.

“The hard disk market used to be fragmented,” Lau explains. “But with consolidation over the last decade, Western Digital and Seagate now hold the majority of market share, and there’s been a big improvement in the industry’s operating margins.”

These companies still have multiples you’d expect from a lower-margin industry, he says. “People have bad memories of the industry’s fragmentation. The [improvements] aren’t reflected in stock prices and this gives us an opportunity, as there’s an explosion in demand for data storage.”

Lau also sees opportunity in the Eurozone. “Some firms refuse to invest in Europe, but when we compare P/E ratios for the MSCI Europe and S&P 500, [the difference] is the widest it’s been in the last two decades. Companies like GDF Suez, a French utility, and Telecom Italia are selling at attractive valuations.”

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Brandes says Japan is a great example of how patient value investing pays off.

He overweighted the country when conventional wisdom said it’s economic woes were extreme enough to make it off-limits to investors. “But a number of companies had strong fundamentals. They were net cash, with no balance sheet debt at all. There was no downside because they were so cheap. The upside was uncertain, but our view is that when you get something extremely cheap it’s a good investment.

“Some clients criticized us. But since November 2012 the Japanese market has gone up considerably, so our approach paid off.”

Read: Bank of Japan rosy on economy

Brandes says there’s still value in Japan, though he’s trimmed his exposure. He likes Nippon Telegraph and Telephone. Some exporters “have been doing well because of the drop in the yen, but they’re getting closer to our sell point,” he says. “A few have gone up 50% to 75% in the last year.”

Lau says emerging markets are widely misunderstood, due in part to geopolitical uncertainty and gloom-and-doom headlines warning of an economic crisis.

The hard data suggests crisis worries are misplaced.

“The average emerging market country has foreign currency debt-to-GDP of 30%. Compare this,” he says, “to the days of the Asian crisis, when debt figures for Thailand and Indonesia were closer to 100%. And if you look at months of import coverage across emerging markets, it’s currently about 8 months of reserves to imports.

“These economies are much stronger today than 10 or 20 years ago. Given their underperformance year-to-date, we feel there’s an attractive long-term entry point.”

Lau notes Chinese state-owned enterprises have a leverage ratio (debt-to-equity) of 5.5x. “That’s more than U.S. high yield, which is at 4x. So we’re avoiding Chinese banks.”

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But there’s still opportunity. Lau singles out Bosideng International Holdings, China’s largest winter down jacket manufacturer. It’s at less than 10x earnings and has a strong dividend yield. “Only 15% of the Chinese population has a winter down jacket, compared to more than half in the developed world. So it’s an underpenetrated market with a lot of consumer growth potential.”

He adds a firm like this will be less exposed to what the government does on a macro level, so “it won’t be correlated to China’s GDP slowdown.”

Dean DiSpalatro